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January 5, 2015

‘Stop Selling Payback’ tED Magazine

Did you see the article in tED Magazine, the magazine for electrical distributors, written by Pat Gormley, president of Gormley-Farrington? In case you missed it, here’s the valuable information that Pat shared with tED readers:

Those of us who sell energy saving products today are doing our market a great disservice by trying to sell based on payback. We should instead be selling return on investment. It may not seem like a significant distinction but it might explain why so many customers are still kicking the energy saving tires instead of buying.
Basically, payback period and return on investment are just two sides of the same coin – two expressions of the same mathematics. In both cases you establish the total cost of a project (investment) and estimate the total annual operating savings (return). Total return should include all energy cost reduction, labor savings, and any applicable rebates or tax credits. If you divide the investment by the return you arrive at the amount of time it will take you to make your investment back – payback period. If you instead flip your fraction around, divide the return by the investment, you arrive and the percent of your investment that you get back each year – return on investment.
Why would one be better at selling projects than the other? It shouldn’t matter. But if you look at a quick example I bet you will agree that return on investment looks more attractive.
Suppose there is a project that will cost $100,000 to install. Assume that you can document $25,000 in annual savings to the client. The payback period ($100,000/$25,000) is 4 years. The return on investment ($25,000/$100,000) is 25%. You can always change from one to the other by taking the reciprocal. A five year payback is a 20% return on investment, 2 years is 50%, 10 years is 10%, etc.

Now if you step back from the math, most sales people will tell you that a 4 year payback will not excite many clients. Perhaps they have been spoiled by stories of paybacks under 1 year or under 2 years. On the other hand, most people know in their gut that a 25% return on investment is pretty good. Now they are thinking about it compared to CD rates, car loans, mutual funds, etc. How many places today can someone reliably get a 25% return on investment?

Bernie Madoff swindled some very wealthy and very intelligent people with promises of 10% return on investment, a significantly above market return. People flocked to his Ponzi scheme due to the allure of 10% return on investment. We offer people legitimate 20%, 25%, 30% returns everyday but get turned away because we are telling them it will take 3, 4, or 5 years to get their money back.

This distinction becomes even better when you consider financing the project. Highly rated corporate bonds are currently trading under 3%; highly rated municipal bonds are trading under 2%. How attractive is it for a company or municipality to borrow money in the low single digits and invest it at 25%? That’s a winner today, not 4 years from now when you complete your payback period. A facility owner can finance an energy saving project and the debt service will be less than the savings – meaning a positive contribution to the current operating budget – every manager’s best friend.

Customers may still ask for a payback period because that is their point of reference and you can easily provide it. But we can better challenge their preconceived notions by stressing return on investment. Do they realize that by requiring a 2 year payback they are rejecting investments that return 30% or 40% to them?
The bottom line is that we are in a slow motion revolution. The adoption of significant energy saving strategies is going slower than it should. Our nation and our environment will benefit from the revolution, but so will our customers and our manufacturers. It’s time to pour some market accelerants on the smoldering embers of change. Stop selling payback – start preaching return on investment.